Choosing between the formal and informal economy: how do managers decide?

Abstract

Purpose

We raise and address an unexamined research question: Why do managers place some business activities in the formal economy and others in the informal? This firm-level managerial choice is most visible in emerging economies and is important due to its performance implications.

Design/methodology/approach

We theorize that managers use social ties with formal institutions (e.g. parliament, central bank) to protect against (1) being singled out for enforcement and (2) opportunistic business partners, and that these protections allow managers to conduct more activities in the informal economy. Based on regulatory focus theory, we also submit that managers with a promotion (prevention) focus mindset are more (less) prone to use their social ties with formal institutions to emphasize the informal economy. Hypotheses are tested using survey data from 362 Lebanese top managers.

Findings

Managers' social ties with formal institutions relate positively to their propensity to use the informal economy, and managers with a promotion mindset are more willing and those with a prevention mindset are less willing to leverage their social ties with formal institutions to conduct activities in the informal economy.

Originality/value

Our study raises an important new research question at the intersection of strategic and international management and offers an initial answer. Working within the informal economy requires informal social ties among informal actors, but for formally registered firms, entry into the informal economy requires informal ties with formal actors.

Citation

Abi Aad, A. and Combs, J.G. (2021), "Choosing between the formal and informal economy: how do managers decide?", Cross Cultural & Strategic Management, Vol. 28 No. 3, pp. 679-701. https://doi.org/10.1108/CCSM-07-2020-0140